TFSA Passive Income: How to Increase Returns, Reduce Risk, and Avoid Paying the CRA

Canadian investors seeking passive income have an opportunity to use their self-directed Tax-Free Savings Account (TFSA) to get great returns without worrying about the Canada Revenue Agency (CRA) taking a chunk of their earnings.

TFSA limit

The TFSA limit is $6,500 for 2023. That brings the maximum cumulative TFSA contribution room to $88,000 per person for anyone who has qualified since 2009, when the government launched the TFSA. In 2024, the TFSA limit will be at least $6,500 and could be bumped to $7,000 if inflation is high enough this year. The TFSA limit is indexed to inflation and is increased by increments of $500.

Interest, dividends, and capital gains earned inside the TFSA and removed as passive income are all tax-free. This means the CRA doesn’t take a cut. That’s great news for people who are struggling to cover rising living costs.

Passive income that is removed from the TFSA opens up equivalent new contribution space in the following calendar year in addition to the regular TFSA limit. Unused contribution room carries forward to future years.

Best investments for TFSA passive income

Investors have an opportunity to get attractive rates on Guaranteed Investment Certificates (GICs) issued from Canada Deposit Insurance Corporation (CDIC) members. As long as the amount is within the $100,000 limit, the invested money is safe, even if the issuer goes bankrupt. This greatly reduces risk in a person’s portfolio. GIC rates above 5.5% are currently available from some CDIC members on terms ranging from one year to three years and above 5% for terms of four years and five years.

One point to keep in mind is that the invested funds are not accessible during the term on non-cashable GICs, which are the ones that normally have the best rates.

Top Canadian dividend stocks have taken a beating this year as interest rates have increased. The slide in the share prices of several dividend-growth stars is a reminder that owning stocks carries risk. However, the steep decline is now serving up very attractive dividend yields.

Enbridge (TSX:ENB), for example, has increased its dividend annually for the past 28 years and now offers a yield of 8%.

BCE (TSX:BCE) raised its dividend by at least 5% in each of the past 15 years. The stock is down to the point where the dividend now provides a yield of 7.5%. Bank stocks are also starting to look oversold and have very attractive yields. At the time of writing, Bank of Nova Scotia (TSX:BNS) has a dividend yield of 7.6%.

Stocks offer more flexibility as the shares can be sold to access the invested funds in the event of an emergency. The yield on the initial investment also increases as the dividend rises. This is different from the GIC, where the rate is fixed for the term.

The bottom line on TFSA passive income

The TFSA is a useful tool to generate passive income that the CRA won’t touch. In the current era of high inflation, it is important for investors to keep as much income as possible to help cover soaring living costs.

Building a balanced portfolio of GICs and high-yield dividend stocks can reduce overall risk while pushing up average returns. In the current market conditions, investors can easily get an average return of at least 6% from a combination of GICs and top dividend payers. That’s above the current inflation rate of 3.8%. Best of all, the full amount of the TFSA passive income can go right into your pocket!

The post TFSA Passive Income: How to Increase Returns, Reduce Risk, and Avoid Paying the CRA appeared first on The Motley Fool Canada.

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The Motley Fool recommends Bank Of Nova Scotia and Enbridge. The Motley Fool has a disclosure policy. Fool contributor Andrew Walker owns shares of BCE and Enbridge.